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Mortgage Strategy News, Issue #001 -- Creative Mortgage Solution
March 17, 2015
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Prickly issues. Creative solutions.A client contacted me for a private second mortgage. He already has a $55,000 home equity line of credit which is a second mortgage and a $43,000 third mortgage with a private mortgage lender who wants to be paid out.
Client wants debt consolidation mortgages strategy that includes cashing out additional $40,000 of home equity -- then lumping everything into a brand new second mortgage loan.
If his home value estimate is correct, his first and the new interest only 2nd mortgage would be at 75% of value.
This would qualify him for a conventional reasonably cost effective private mortgage financing.
What prickly issues ?Although his credit is good, he's a year behind on property taxes. This is a problem for a lender as by law, property taxes in arrears take priority over any existing first mortgage.
Amount of income he is generating from all sources does not support a private second mortgage in the amount of money requested.
Private mortgage lenders can be flexible and creative. They may accept as high as 60-65% of your income going to service mortgages, property taxes and other debts.
But, close to 80% can be a deal breaker.
Even if there is lots of equity available, lenders want to feel that you can make your mortgage payments. No one wants to force a sale of your home to recover their investment.
Now about the proverbial "home equity".
Client bought the home for $395,000 as the real estate market was on it's way up. In less than six years the property values in the area skyrocketed. Recent sales in the neighborhood are ranging from $700,000 to $800,000. Our client feels his property is now worth $750,000 -- a hefty $355,000 increase.
Now in 2015, is this a reasonable value increase or an inflated property heading for a real estate bubble bust? From $395,000 purchase price in late 2009 to $750,000 today?
Appraisers' dilemaAlthough the property is in close proximity to a major Ontario city with skyrocketing property values, we've now enjoyed over 10 years of a hot real estate market.
With interest rates at their lowest and property values at record high, many brilliant minds contend that our real estate may be heading for a correction.
In their opinion, 10% - 25% drop in property values is not that far fetched.
With most borrowers buying their homes for the maximum amount and minimum down payment they qualify for, what will happen once the interest rates start climbing?
Historically, property values have been known to drop with rising interest rates. Even a small drop of 10%, considered a soft landing, can be disastrous for a lender.
10% on $750,000 reduces the property value to $675,000 and taking the proposed mortgage up to 85% of value -- this is a much riskier exposure for the private lender.
Mortgage strategy solutionAppraisers have a fiduciary duty to take all property aspects and market conditions into consideration when appraising a property.
Private mortgage lenders choose appraisers with experience, discipline and foresight to appraise the properties they will invest in.
Lending value is not the same as market value.
In our case, the initial appraisal came in at $725,000. To adjust for the overheated market conditions in the subject area, the appraiser discounted the lending value by 5% to $688,000.
It's always difficult for clients to understand why the appraised value for financing comes in so much lower than comparable market sales.
Appraisers are looking at the consequences of possible near term market decline when the said mortgage comes up for renewal.
So what happened on our deal ?
Given the lack of income and lower appraised value, this mortgage got funded by a high risk lender at 85% loan to value pricing. In addition, the borrower had to provide a co-signor as added security.
What's with the interest rates ?The Canadian economy has recently showed some risk of decline from the steep drop in oil prices. Oil is a large part of Canadian economy.
The Bank of Canada took quick steps to mitigate the damage. At the January meeting, the Bank of Canada lowered their overnight lending rate by 25 basis points.
If oil prices continue to drop, the Bank may cut again at their next meeting. Or, they may do nothing and watch.
Does this mean savings for you ?
Not necessarily. The Bank of Canada cuts do not necessarily mean that these savings will be passed onto you.
After the January drop, it took three weeks of pressure for the retail banks to reduce their Prime rate by 15 basis points to 2.85% -- not the 25 basis points they gained from the rate drop.
Suggestions ? Questions ?If you have comments, questions or suggestions for future newsletters, I would love to hear from you.
Thank you for your interest in our Mortgage Strategy News. Use this link to contact Marie.
Marie Copeland, FSU Mortgage Broker
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